The Red Sox World Series Run Can Teach Investors a Valuable Lesson About Turnarounds

The Boston Red Sox pulled off one of the most remarkable turnarounds in major league baseball history in 2013. For the first time in franchise history, they went from last to first, and are now just two games from winning the World Series against the St. Louis Cardinals.

I watched dozens of Red Sox games this year, and have been following the team since 1967 – when coincidentally, they also played the St. Louis Cardinals in the World Series. The most striking thing about the turnaround this year is that it was pretty simple, and didn't require as many drastic changes as many people think. In a nutshell, here's how they did it:

Core players were able to avoid injuries.

The starting pitching didn't suck.

Koji Uehara – our closer had one of the finest seasons ever for a reliever.

You'll note that there's no mention of beards or grizzled-veteran leadership or any other intangible factor. That's not to say the intangibles weren't important, but the list above was primary.

Jonah Keri, who writes for Grantland, came to a similar conclusion about the Red Sox this year. After looking at all of the data, he concluded that the Red Sox in 2013 were always a good team, but "it was just really tough to see for a while." This might not be a very profound observation, but it's potentially an invaluable insight for investors.

2013 vs. 2012: by the numbersIt's easy to see how the Red Sox did it when you consider some of the basic numbers.

The Sox won 28 more games in 2013 than they did in 2012, and their run differential (runs scored minus runs allowed) was a major league best 197. Perhaps most importantly, the team's ERA was almost a full run better in 2013.

It's tempting to explain this amazing turnaround by focusing on the decision to get rid of big names like Carl Crawford, Josh Beckett, and Adrian Gonzalez, while bringing in team players like Shane Victorino and Mike Napoli. But the bigger reason for the Sox's success was that the traditional core – David Ortiz, Dustin Pedroia, and Jacoby Ellsbury -- was healthy.

As Keri notes in his Grantland piece, Ortiz only played in 90 games in 2012, while Ellsbury only played in 88. Pedroia played in 141 games, but was essentially muscling through with a badly injured thumb. Just having all three back in the lineup for most of the season made a huge difference in 2013.

On the starting pitching front, something similar happened. Our two top pitchers – Jon Lester and Clay Buchholz – had a combined 20 wins and 22 losses in 2012 with ERAs of 4.82 and 4.56, respectively. In 2013, they were a combined 27 and 9 with ERAs of 3.75 and 1.74, respectively. What happened? They, um, pitched better.

The final piece of the turnaround was a bit unlikely. The Japanese setup man Koji Uehara was thrown into the closer job early in the season, and then something crazy happened. He had one of the finest seasons ever for a reliever. That was a huge piece of the puzzle, and signing him to a contract was an inspired decision by the Red Sox management team.

Lessons for investorsSo what does all of this mean for investors?

Let's stop and think about what happened to the Red Sox over the past couple years. In the last month of the 2011 season, the Sox lost 20 out of their final 27 games, and missed the playoffs after losing the last game of the season. Then in 2012, they had their worst season since 1965. Entering the 2013 season, the odds of them making the World Series were 28 to 1.

And yet, the team still had their core talent pretty much in place. Things looked bad for the Red Sox, but the team was much, much better than everyone thought. That's precisely the type of situation investors should be looking for.

In the investing world, a similar example might be Netflix (NASDAQ: NFLX) . In the summer of 2011, the company's share price had soared to $300 per share. But then, after some missteps by management and a realization by investors that the pivot to streaming video would be harder than expected, the share price plunged dramatically.

Of course, now we know that the market was confused about Netflix's future. As of today, the share price is back over $300 per share. For those lucky investors who bought shares in the summer of 2012, they now have a five-bagger. Ironically, Netflix's recent turnaround from 2011 through 2013 sort of parallels that of the Red Sox.

We now know that Netflix, after its shares cratered in 2011, represented a great opportunity for investors. The company still had enormous talent and its culture remained second to none. The demand for its offerings was still huge, and the company had a proven history of evolving and overcoming competitive threats. Given all of that, my colleague David Meier and I thought it was worth making a small investment in Netflix back July, 2012. It was still a great company – it was just cheaper than it had been before.

The Astros are another story altogetherNot all turnarounds are simple or successful, of course. J.C. Penney, for example, brought in former Apple superstar Ron Johnson, and things got even worse. The new strategy was probably too ambitious, and the company lost almost a billion dollars. Perhaps the challenge facing the company was too difficult.

The same is true in sports. Some teams, like the Houston Astros, have just too many problems, and are unlikely to go from last to first in just one season. The key to spotting turnarounds in baseball and investing is to find talented organizations that have somehow stumbled, despite retaining all of their previous advantages. This formula appears to be particularly promising, though it's unrealistic to expect five-baggers or World Series championships on a regular basis.

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